Saturday, 30 April 2016

On 25 April, Saudi
Arabia unveiled its national
vision, a set of goals it wants to achieve by 2030. A central theme in the Vision 2030, a brainchild of the Deputy
Crown Prince Mohammad bin
Salman, is putting an end the country’s chronic reliance on oil. Some
have lauded the announcement as the long-awaited push Saudi Arabia has always
needed. Others called it a mere
public relations exercise. On balance, caution must be the order of the
day. Any claims that Saudi Arabia is already on track to end its “addiction to
oil” in the next few years are premature for four reasons.

1. Announcing a national vision is not new in this region. In fact, Saudi Arabia is a late joiner. Bahrain, Kuwait, Oman, Qatar and the United Arab Emirates (ie all other Gulf countries) have all published their own national visions years ago. The publication did not ensure timely implementation or immunity from the decline in oil prices.

2. Vision 2030 is a set of long-term goals or targets, not a concrete plan of how to achieve them. A plan should be released in May/June under the title of National Transformation Plan after a few months’ delay. But to put it briefly: a vision is not a plan; and having a plan does not guarantee execution.

3. Execution of any plan is likely to prove difficult. There are signs of difficulty even this early in the process. Only days before the announcement of the vision, the Saudi water and electricity minister was fired following public outcry over higher utility tariffs. Public dissatisfaction could intensify as more difficult measures are rolled out.

4. One of the
most headline-grabbing measures—the plan to replace oil revenues with the proceeds
from a $2 trillion sovereign wealth fund—is unrealistic. Even if the fund reaches
the required size and somehow manages to increase the share of its foreign
investments to half from 5% currently (domestic holdings are mostly oil related),
an optimistic return of 7% on overseas assets would generate only $70bn per year. This would
not be enough to replace oil revenues and finance the expected budget deficits,
which together totalled $216bn in 2015 for example.

Overall, the attempt
to transform Saudi Arabia’s economy away from its oil dependence is needed, and
steps taken towards this are positive. But a viable plan is required to show
how this ambitious target can be achieved. Even then, the actual implementation
of the plan will be key.

But while expectations
about the impact of the Doha summit ranged between neutral and positive before the
meeting, the assessment of its no-deal outcome was decidedly negative. The meeting
showed that the competition between Iran and Saudi Arabia is spilling over to
the oil market. If this translates into an escalation of the market share war
between the two countries, then the ongoing
rebalancing in the oil market could be derailed.

What are the signs of
increased Iranian-Saudi competition in the oil market?

First, there were
reports of a price
war between the two countries. Following the lifting of its sanctions in
January, Iran has been offering aggressive discounts on its oil in order to
gain market share in Asia.

Third, the
comments from the Saudi Deputy Crown Prince, one day before the meeting, emphasising
his refusal to participate in any production freeze unless Iran joins in. He also
threatened to increase production by one million barrels per day immediately. “I
don’t suggest that we should produce more, but we can produce more,” the prince
was reported to say.

If this threat is implemented,
it can flood the oil market with yet more supply. But it is not expected to,
because it is in nobody’s interest to do that. Nonetheless, it would be worth
watching production data closely in the coming months.

Monday, 11 April 2016

The
Saudi austerity plan is too stringent and, if implemented, could be damaging for growth.

The fall in oil
prices has hit Saudi public finances. The government’s budget balance switched from
a surplus of 6% of GDP (a measure of the size of the economy) in 2013 to a large
deficit of 15% in 2015. At this level, the Saudi budget deficit is unsustainable.

In an interview with Bloomberg last week, the Saudi deputy crown prince, Mohammed
bin Salman, and his team reiterated their plans to achieve a balanced budget by
2020. If this plan is implemented, Saudi Arabia will embark on an austerity
programme more stringent that the one which had sent Greece into a depression. And
it will be executed under more challenging economic conditions that the ones
Greece had faced. The plan could prove more damaging than helpful for
the Saudi economy. Therefore, it is unlikely to be strictly implemented.

- Through raising $100bn
of additional non-oil revenue by 2020. The new sources of revenue include the introduction
of a value-added tax (VAT) and other fees and the removal of subsidies.

- Assuming no additional
oil revenue (“We try to focus on the non-oil economy,” bin
Salman said), and public spending that is fixed at 2015 levels, the additional
$100bn of non-oil revenue should be enough to balance the books.

How large is this
austerity programme?

- A move from a
deficit of 15% of GDP to a balanced budget within five years is very large.

- Such programme
would be more stringent than the austerity programme which had sent the Greek
economy into a depression. Greece reduced its budget deficit from 15% of GDP in
2009 (similar to Saudi Arabia today) to a deficit of 4% five years later (Saudi Arabia plans 0%).

- It would also be
more austere that the programme implemented by the Conservative-led government in
the UK, where the budget deficit went from 13% of GDP in 2009 to 4% in 2014.

What is the likely
economic impact of the Saudi austerity plan?

- Judging by the
experiences of Greece and the UK, the plan is likely to be quite damaging for
growth in Saudi Arabia.

- Moreover, the
Saudis will be implementing their austerity measures under more difficult conditions
than the ones either Greece or the UK had faced.

- While
their governments were engaged in austerity, the central banks in both Greece
(the Euro Area) and the UK reduced interest rates in an attempt to boost growth by
stimulating lending and investments.

- Saudi
Arabia does not have that luxury. Saudi interest rates are linked to the US because
of the currency peg to the US dollar. Indeed, when the US
raised interest rates in December, the
Saudis swiftly followed.

- US interest rates are expected to rise over the medium
term, which means that Saudi rates will also rise, increasing the cost of
borrowing for households and businesses and inhibiting consumption and
investment.

- The private sector is unlikely to step in to fill the hole left
by the government. It will face increasing costs as subsidies are
removed and VAT is implemented.

What is the way forward?

- Saudi Arabia needs to reduce its budget deficit. A deficit as large as
15% of GDP cannot be sustained beyond a few years.

- But the plan to balance the budget in five years is too ambitious and
could be damaging for growth and counter-productive for debt sustainability. It
is therefore unlikely to be strictly implemented.

- The optimal speed of fiscal consolidation is somewhere between the two
extremes of doing nothing and doing too much too fast. Let’s leave identifying
this speed to future work.

Sunday, 3 April 2016

The International
Monetary Fund (IMF) completed the first review of its staff-monitored
programme with Iraq last week. The programme is an agreement to monitor the
implementation of the Iraqi government’s economic agenda and does not involve
any financial assistance. But four reasons suggest that it may well be
converted to a full-fledged loan even before it expires at the end of this
year.

1. Iraq has large
financing needs. The fall in oil prices has reduced the government’s revenue leading to a large budget deficit, forecast by the IMF to be 10% of GDP in 2016.
Lower oil prices have also reduced export revenue, leading to a large external
deficit of around 6% of GDP in 2016 (see chart).

2. Iraq has limited
options for financing. The attempt to borrow from financial markets last
year fell through due to weak investor appetite. Reserves can finance the external deficit for
roughly three years, but at the risk of depletion and potential devaluation. Indeed,
the central bank has been using its reserves to finance nearly half of the
deficit. This left the government with little choice but to accumulate
significant arrears to finance some of the other half.

3. Iraq is making
some progress in meeting the IMF’s targets. The review has shown
that three out of the five quantitative targets were met, with a fourth
narrowly missed. The only failure was the inability of the government to avoid
arrears. The programme had also structural targets related to surveying and
measuring the exact size of accumulated arrears and to look into the financial health
of state-owned banks. Good progress has been made on these targets according to
the IMF, although only one of them was met.

4. The IMF is
likely to be lenient with Iraq. Any decision may well involve a bias to help
Iraq at this difficult moment, especially given its war with the Islamic State
in Iraq and Syria (ISIS).

So a full-fledged
IMF programme involving a loan may materialise before the end of the year, perhaps
even as early as June, barring a complete political collapse in Iraq. The
programme could mobilise as much as $15bn over three years from the IMF as well
as other institutions and governments. In return, it would require the
government to cut spending further, which may prove painful. But it could also
help the country avoid devaluation, given that the IMF still views the exchange
rate peg to the dollar as the only constant in an otherwise messy and highly
uncertain environment.

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About Me (Ziad Daoud)

I am an economist currently based in the Middle East. I have previously worked for an asset management firm and, before that, I did a PhD at the London School of Economics. The views in this blog are solely my own.